An active approach to fixed income

Passive bond indices typically weight the largest issuers most heavily, just like the index they track, regardless of whether these issuers are attractive from a risk-return perspective. An active approach enables investors to select countries, companies or sectors in which to invest and to deliberately avoid problematic issuers.

Bond markets are broad and significantly less homogeneous than many stock markets. It is precisely this diversity that creates scope for differentiated selection. In emerging markets, for instance, the differences between individual countries are particularly pronounced. Active managers assess individual regions, issuers and bonds, investing where they believe to identify an attractive risk-reward profile.

Many segments of the bond market are subject to less intense scrutiny than large, liquid markets. This can be the case with emerging-market bonds, high-yield bonds, subordinated financial bonds or smaller issuers, for example. As these markets are often influenced by local factors and do not always directly reflect developments in major industrialized countries, mispricing can occur. Active management can help to identify such inefficiencies and factor them into investment decisions. However, there is no guarantee that this will result in added value.

Inflation, monetary policy, economic conditions and geopolitical developments can have a significant impact on bond markets worldwide. Active managers continuously monitor these risks to the portfolio and manage them by making appropriate adjustments to the portfolio—rather than merely passively following market trends. The goal is to mitigate potential risks of loss. These risks cannot be completely ruled out.

Not all attractive investment opportunities are included in mainstream bond indices. These include high-yield bonds, subordinated bonds and bonds issued by smaller issuers, for example. Active managers can examine and incorporate such areas specifically, whereas passive strategies often provide limited coverage of them. This broadens the investment universe and can tap into additional sources of return.

New bonds are initially offered directly by the issuer (primary market) before being traded on the secondary market. In order to successfully place an issue, issuers may offer investors more attractive terms at the time of the initial offering. This decision is often based on prevailing market conditions. Active managers can review such new issues early on and, drawing on their relationships with issuers and underwriting banks, participate selectively in them. Managers of passive strategies often do not gain access to these bonds until they reach the secondary market.

In the bond market, returns do not come solely from regular interest payments. Changes in interest rates and, for international investments, currency movements can also make a significant contribution. This is particularly true for emerging market bonds. Active managers continuously monitor these developments and consistently align their selection of markets, maturities, and currencies in their bond portfolios accordingly. However, the success of this strategy is not guaranteed.

When investing in stocks, investors purchase shares in a company and participate in its performance. With fixed-income investments, investors lend money to a government or a company by purchasing fixed-income securities. In return, they receive regular interest payments over a specified period. Stocks often offer higher potential returns but are generally subject to greater price volatility than bonds.

Government bonds are considered relatively low-risk investments. The level of risk they entail depends on the financial strength of the issuer. By international standards, Swiss government bonds are among the securities with the highest credit ratings.

Credit risk encompasses default risk and credit quality risk. Default risk is the risk that the issuer of a bond will become insolvent and therefore be unable to meet its payment obligations, which include regular interest payments and the repayment of the initial investment at maturity. Credit quality risk is the risk that the issuer’s financial situation—and thus its creditworthiness—will deteriorate. The higher the risk of a bond, the higher its risk premium is generally, which is intended to compensate the investor for this risk.

Fixed-income trading refers to the buying and selling of fixed-income securities in the financial markets. Institutional investors actively trade bonds to optimize returns or manage risk. Individual investors typically invest through funds or structured products, as individual bonds often require high minimum investment amounts.

The market value of a bond can fluctuate during its term, especially when interest rates change. If interest rates rise, outstanding bonds tend to lose value because newly issued bonds offer more attractive terms. The closer a bond gets to maturity, the more its price generally approaches its redemption value—provided the issuer remains solvent. Anyone who buys a bond below its redemption value and holds it until maturity can benefit from a capital gain in addition to the interest payments.

Fixed-income investments can provide stability to a portfolio, generate regular income, and serve as a counterbalance to more volatile asset classes. During periods of heightened market uncertainty, the predictability of interest payments can be important for portfolio management. However, fixed income is not risk-free: bonds can come under significant pressure when interest rates rise sharply or inflation is high. Whether fixed-income investments are suitable for an investor depends on their individual investment goals, risk tolerance, and personal financial situation.